Electricity Market FAQ

Q. What is the difference between deregulated, restructured and competitive electricity markets?

A. All three terms are frequently used to describe the state of today’s electricity markets. Deregulation is a misnomer. Electricity markets have not been deregulated anywhere. Instead, electricity markets have been restructured to introduce as much competition as possible among generators while maintaining strict regulation over the transmission and distribution wires business. Electricity markets are governed by extensive rules and regulations at both the wholesale and retail levels. At the wholesale level, the Federal Energy Regulatory Commission (FERC) closely monitors generators and marketers that charge market-based rates to ensure that they do not have market power or engage in prohibited behavior, and the agency requires non-discriminatory access to the transmission grid at regulated rates. In some regions, highly organized wholesale markets, in which the energy resources are bid and dispatched in hourly and daily auctions, are operated by RTOs and ISOs. At the retail level, some states still maintain utility monopolies while others allow providers to compete to provide energy service. In states that allow competition, the local public service commission still regulates distribution wires and oversees structured programs for competitive electric energy suppliers. In addition, some restructured state programs require incumbent utilities to provide energy service at regulated rates to customers that choose not to shop around.

Thus, the term “restructured electricity markets” most closely describes the wholesale markets operated by RTOs and ISOs and the retail markets in states that allow competing energy providers. The structure has changed to allow competition for some services but maintain strict government regulation over certain parts of the industry. And importantly, no products or services have been deregulated.

Q. What are ISOs and RTOs?

A. An RTO is a regional transmission organization and an ISO is an independent system operator. Both types of entities are functionally the same: they operate and manage the interstate electricity grid over a large region, dispatch the system by means of auction-based energy markets, and provide market monitoring oversight. A key characteristic of both ISOs and RTOs is that, in contrast with grid operators in utility operated systems, they are not affiliated with any market participant and thus provide the fair access to grid services needed for a level playing field. And both RTOs and ISOs dispatch the system by means of competitive auction-based energy markets, in contrast to the purely bilateral markets in single utility operated systems. The grid operators in New York and California are ISOs, not RTOs, because of their single-state geographic scope. The important point of both ISOs and RTOs is that they are not affiliated with any market participants and thus provide the fair access to grid services needed for a level playing field. RTOs and ISOs serve about two-thirds of electricity consumers in the U.S.

Q. What is a capacity market?

A. Unlike other types of energy, electricity can’t be stored, so every time someone turns on a light some resource has to produce more electricity or reduce output when the light is turned off. To meet federally mandated reliability requirements, grid operators must ensure that electricity suppliers not only have enough resources to meet their customers’ expected peak demand, but also some cushion, or “reserve margin,” they can tap to meet unforeseen demand or unexpected unit outages. This reserve margin acts like an insurance policy, ensuring that the lights stay on even during extreme system conditions.

ISO New England and the PJM RTO operate capacity markets to ensure electric system reliability at the lowest possible cost. These capacity markets use competitive auctions to lock in firm prices on electric capacity from resources three years before they are needed. These auctions focus solely on selecting only the cheapest resources to meet future needs reliably and thus guarantee the lowest cost reliability solution. The least cost reliability solution can be met by upgrading an existing unit; reactivating a previously retired unit; deferring the retirement of an existing plant; building a new plant; investing in transmission; or consumers can reduce usage through energy efficiency or demand response, which pays customers to reduce their consumption or contribute with other generation resources. Prices do not differ between new or existing resources or by fuel type, but are based on location and timing of the capacity commitments. Before these markets began, price signals were short term in nature, inadequate to support existing assets and incent new development, and discouraged demand response from participating in the market.

It is important to understand that even during the days of monopoly utility regulation, utilities maintained an extra cushion of resources, primarily generation resources, to provide power during extreme system conditions. Customer charges for this essential service were imbedded in monthly electric bills. The need for charges to cover the costs of maintaining adequate resources still exists today, but what’s different is that through the capacity markets, these capacity charges are now transparent and are determined through the discipline of an open, competitive auction in which all resources compete, and the pool of competing resources is much larger because of the large geographic footprints of the ISOs and RTOs.

Q. Have electricity prices increased more in restructured states than in monopoly states?

A. No, and in fact they have increased significantly less than in monopoly utility states. According to an analysis of data from the Energy Information Administration and the Bureau of Labor Statistics, between 1997 and 2011, retail rates for all sectors in states with restructured retail markets increased only 1% compared with an 8.8% increase in states that rely on monopoly utilities (when adjusted for inflation). And inflation-adjusted rates for residential and commercial customers in restructured states have actually decreased over this period by -3.8% and -6.3% respectively, while residential and commercial rates in monopoly utility states have increased by 4.2% and 2.7% respectively.

Q. Has restructuring been good for consumers?

A. Yes. Because they restrain prices better than the monopoly markets (as discussed above) and allow choice and flexibility for customers, restructured retail and wholesale markets produce substantial savings on electricity costs. For businesses, electricity is one of their largest operating costs. Competitive electricity markets help lower costs and provide the flexibility to choose a supplier that best meets individual business goals with service offerings that provide choices on price, reliability, generation portfolio mix, and risk management tools. Empowering businesses and other customers to manage their electricity costs means savings, lower prices for customers and job creation.

Another source of cost savings in restructured markets is demand response, which flourishes in competitive electricity markets. Demand response providers have introduced product and service innovations that allow consumers to reduce or modify their electricity consumption to gain better control of their electricity use and costs. This helps to keep prices down and avoids the need to build expensive new generating plants.

Restructured markets provide a superior platform for the emerging Smart Grid technologies. Sophisticated Smart Grid tools will give customers a greater ability to take advantage of the market’s transparent price signals and make smart consumption and investment decisions.

Restructured markets bring environmental benefits. In a Joint Statement of General Principles, COMPETE and the Environmental Defense Fund recommended “market-based mechanisms both to encourage the efficient operation and use of existing and new resources and to achieve environmental improvements through conservation and biddable demand response.”

Finally, competitive electricity markets diminish financial risk for customers by shifting the risk of poor business decisions from consumers to investors, where it belongs. Competitive providers are not guaranteed recovery of their costs from captive customers, as are monopoly utilities. Instead, service providers must provide a superior service at a lower cost than their competitors. Thus, the risk of poor investment decisions is borne by those providers and their respective shareholders, not by captive customers.

Further proof that restructured retail markets benefit customers is demonstrated by the number of customers who actually shop for alternative suppliers where they can. In the 17 states and the District of Columbia where retail competition is allowed, competitive providers supply 68% of eligible non-residential demand and more than 31% of residential demand. During the economic slowdown between 2008 and 2011, electricity usage in the continental U.S. declined by slightly less than 1%, but the electricity demand served competitively surged by 40% and the number of customers served under retail choice grew by over 53%.

At the wholesale level, the organized markets are producing cost savings through enhanced reliability, more efficient use of a region’s existing transmission and generation assets, and a reduced need for new assets. For example, PJM estimates that its operations save its region $2.2 billion each year, and the Midwest market operator estimates that it provides between $2.2 billion and $2.7 billion a year in regional benefits,

Q. Weren’t the “good old days” of monopoly regulation better for consumers than restructured competitive markets?

A. No. They were costly, wasteful and detrimental to progress. The old system of government-determined, cost-based regulation brought customers poor performance in terms of too much generation capacity that almost always cost more than expected, power plants that were not available as much as they should be, declining investment in the electric transmission system that would otherwise have broadened customer access to the lowest-cost resources, a one-size-fits-all product for consumers, and a culture that was resistant to new and innovative technology. Customers paid for this inefficiency in their monthly bills. Between 1970 and 1985, before the advent of restructured markets, rates for residential customers more than tripled (25% in real terms) and rates for commercial customers quadrupled (86% in real terms). And consumers had no ability to manage their purchases with a choice of suppliers or electricity service that fit their needs. And as set out in response to an earlier question, from 1997 through 2011, rates in restructured states increased a smaller percentage, or even decreased, in stark comparison with the larger percentage increase in monopoly states.

Q. Have restructured markets spurred innovation?

A. Yes. As discussed above, retail service providers are providing innovative new services to meet customers’ needs and preferences regarding price, reliability, generation portfolio mix, and risk management tools. Restructured markets spur new entry by product and service providers, and are attracting new entrants that bring technical innovations. For example, innovators such as renewable energy companies, demand response providers, and cutting-edge storage resources using state-of-the-art battery or flywheel technologies, are choosing to install their advanced equipment in the organized wholesale markets due to those markets’ fair entry rules and transparent prices that accurately indicate resource value. Markets, in contrast with monopolies, provide price signals and the level playing field on which renewable energy suppliers, demand response providers and technology companies can compete to provide new products and services.

A. No. In fact, there is a substantial amount of evidence that competitive markets across the country are bringing a broad range of benefits to consumers, and consumers are choosing products and services of competitive suppliers where they can.

Regarding California, a Federal Energy Regulatory Commission staff investigation of the California electricity crisis concluded that “significant supply shortfalls and a fatally flawed market design were the root causes of the California market meltdown” and that these factors enabled the unlawful behavior of Enron and other unscrupulous market participants. Policymakers and lawmakers have learned important lessons from the California market experience. For example, in the old California market designed by the California legislature, all of the load-serving utilities were required to purchase their power supplies on the hourly energy market. Today, the organized markets allow hedging instruments, such as long-term contracts, to help manage price risk. In addition, California and all of the organized markets (i.e., those operated by RTOs and ISOs) in the U.S. now have strict rules and structures in place to prevent manipulation and are actively monitored by independent experts. And since the California crisis, the FERC has adopted strong anti- manipulation regulations and Congress enacted legislation giving the agency the authority to levy penalties of up to $1 million per day for each violation.

Federal and state regulators have significantly modified electricity markets around the nation over the past decade based on substantial experience with electricity market design and opinions from both U.S. experts and those around the world. As discussed in response to an earlier question, wholesale and retail markets are now structured to benefit customers, oversight is pervasive, and many states are now seeing significant consumer benefits flowing from markets. The bottom line is that policymakers wanting to take advantage of the benefits competition can bring have learned a lot over the past decade about what works and what does not, and are structuring electricity markets accordingly.

Q. What are the environmental benefits of competitive electricity markets?

Competition also provides consumers with more environmentally sound choices. New power generation, innovation, greater use of renewable energy, and competitive pricing are the hallmarks of competitive electricity markets. For example, restructured markets have fair rules and pricing and operational protocols that better accommodate the variable nature of renewable generation resources. Nearly 80% of installed wind capacity is now located in regions with organized competitive electricity markets, despite the fact that these areas represent only 44% of U.S. wind energy potential.

In addition, competitive markets provide the real-time price signals that facilitate conservation by consumers and innovation by providers. Transparent price signals enable demand service providers to help customers lower their consumption or shift it to times of lower demand and lower prices.

A. FERC defines demand response as “a reduction in the consumption of electric energy by customers from their expected consumption in response to an increase in the price of electric energy or to incentive payments designed to induce lower consumption of electric energy.” Demand response programs enable customers to save or make money by reducing consumption or shifting it to times when demand and prices are lower. Retail customers and aggregators of retail customers that bid directly into organized wholesale energy markets are, under FERC policy, treated as a resource that keeps the system in balance just like a generator. Retail customers also participate in state demand response initiatives based on dynamic and time-differentiated retail price signals.

As discussed above, demand response resources are attracted to the organized wholesale markets because of those markets’ fair entry rules and transparent prices that accurately indicate resource value. Demand response resources in U.S. organized markets increased by more than 16% between 2009 and 2010 and measured almost 32,000 MW, or 7% of the peak load of those markets. At that MW level, demand response resources in organized markets are equivalent to between 35 to 45 base load power plants. In addition to displacing the need for expensive new power plants, FERC has found that demand response resources in the organized markets can help reduce electric price volatility, mitigate market power, and enhance reliability.